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Tuesday, 18 November 2014

Merpel was in the process of deciding between duck with animal derivative sauce and fisherman’s feast when another type of derivative caught her eye. Leaving her saucy decision to the side, she though she’d paw through the 2013 financial statements of the European Patent Office. Readers can find them here [pdf].

How does the EPO have a balance sheet of a small profit, larger comprehensive income, assets of nearly €8 bn and liabilities of €12.4 bn? The answer boils down to its pensions liability. All of this is of great interest to EPO employees and contracting states.

Unlike the occasional bank, the EPO cannot go bankrupt, as contracting states are obliged to finance any deficit. Renewal fees from EPO granted patents contribute the majority of many offices’ revenues. For national offices, the EPO is both a major source of income and possibly their biggest liability.

Employees are no doubt interested, as recent strikes demonstrate, and the true financial position of the EPO has been an issue in contention in the current employee unrest. EPO employees are also in an unusual position where they are highly skilled but have few non-EPO employment options.

Pensions

How did the EPO get to this position? In 2009, the defined benefit liability (which includes pensions) was only €5.9 bn (even in 2013 Euros, that is only €6.8 bn) compared to the current estimate of €11.1 bn.

Projecting the gains and losses associated with the pension’s liability is an art, not a science (Merpel sniffs at this as her crystal ball always predicts when dinner will arrive.) There are assumptions and uncertainties in financial projections that can change. For example, an increase in one month of life expectancy at retirement age increases the EPO’s pensions liability by nearly €11 million (this perplexes Merpel, surely every cat has nine lives?)

However, the answer lies in discount rates. The main change between estimates in 2009 and 2013 is that the discount rates used to value future pension obligations dropped from 5.3% in 2009 to 3.9% in 2013.

How are these magical discount rates set? The EPO uses actuaries who calculate rates using the interest rates of corporate bonds. In the aftermath of the 2008 financial crisis, governments began dropping their interest rates and corporate returns followed. Quantitative easing kicked in, returns dropped further and we now have ballooning pensions deficits across Europe.

For readers who drifted off in the last paragraphs, here is the headline: investment returns have gone way down, so the amount of money need to fund future payments (pensions) has gone way up.

Renewal fees

Unusually, the EPO cannot include future renewal fees in its statements. This is despite the fact that renewal fees, not procedural fees, cover the costs for EPO-granted patents. However, renewal fees are not a legal obligation and are not counted in all statements. At the same time, the EPO is required to take them into account when setting its procedural fees. The 2013 statement estimates future renewal fees as €3.5 bn.

Merpel thinks this is a tricky situation to be in, but it is probably fine as long as patent applications continue to increase. She also sees this as prudent, as Tesco’s strategy of timing costs and incomes has made her rethink her sardine supplier.

Other mew-sings

How can the EPO afford a new building? This is where the financial world of numbers splits from the practical world of bricks. Accounting calculates wear and tear on buildings as a cost (depreciation.) The Hague building has been depreciated to zero as it is at the end of its useful life. The new building will be listed, not at its market value, but as an asset equal to its price tag minus any depreciation. This can make the gleaming building a bargain, as the annual depreciation may be less than the equivalent rent.

Finally, what about assets of nearly €8 bn? Just over €5 bn of this is the pensions fund itself. The other €2.8 bn are a mix of tangible and intangible assets, bonds, home loans to staff and other assets. These assets represent the savings account for the EPO, which has a stabilising influence and serves as a rainy day fund. The question remains whether the pensions liability truly is a storm.

Overall, the EPO faces future incomes that are fairly fixed (patent fees) and costs that are volatile and have seen unprecedented increases (pensions.) Additionally, it can’t include the bulk of its income (renewal fees), estimated to be €3.5 bn. This still leaves €8 bn + €3.5 bn = €11.3 bn < €12.4 bn. Readers may be right to withhold final judgement, as the past decade has demonstrated how wrong financial predictions can be.

What might change this? Improvement in the economy could reduce liability and increase total fee income. Yet life expectancy and higher health care expenses are increasing and may increase the pension liability.

Before she returns to her dinner deliberation, Merpel notes that she is not an actuary and hopes that that informed readers will correct her if she’s got the wrong end of the catnip. An enigma wrapped in a tasty conundrum, the EPO’s statements are food for thought.

21 comments:

Well the renewal earnings can be adjusted upwards is necessary. The EPO take 50% of post grant renewals on EPs, but the Administrative Council can fix a higher amount (up to 75%) pursuant to Article 39(1) EPC.

I guess they could also look doing what a large number of other organisations have done, when faced with a similar ballooning pension liability: close the defined benefit scheme for any new staff, and/or require increased contributions from staff to cover the liability.

"Merpel thinks this is a tricky situation to be in, but it is probably fine as long as patent applications continue to increase."

Except EPO applications have not increased. Actual applications filed at the EPO (not counting PCT applications which do not enter the European phase) have been fairly flat - 150,961 in 2010; 142,810 in 2011; 148,494 in 2012; 147,869 in 2013.

Yes, 2010 was a bumper year because of divisionals, but an overall trend is not particularly clear. Any increase is marginal, and does not match up with the increased liabilities reported in the article.

It appears that Benoit Battistelli is being aggressive about cost management and efficiency. Senior staff are on fixed term contracts and do not get a defined benefit pension (see previous IPKat blog posts). Total staff numbers are not increasing, and with e.g. the increasing use of online filing, changes to fee payment rules and systems etc., back office and support roles at the EPO are being reduced.

A lot of these developments are being lead by the EPO, and there's a clear tangible benefit to the EPO if it can (a) become more efficient in handling applications, and (b) encourage more filings.

Personally, I wonder whether we might see an increase in opposition and appeal fees since overall they cost the EPO vastly more than the fee income they generate.

EPO staff might not be happy about Mr Battistelli, but I would suggest that the EPO financial liabilities and the fact that he appears to be trying to address them (or at least bring them under control) will ensure that the Administrative Council continue to support him.

"I wonder whether we might see an increase in opposition and appeal fees since overall they cost the EPO vastly more than the fee income they generate". This is true, but in terms of numbers (relatively) unimportant.

What is a problem is that procedural fees at large do not cover costs. Hence, increasing the number of PCT searches done by the EPO normally increases their costs and liabilities by more than the income from the fee.

Of course the recent extension of PCT search services will actually enable mugs to pay lots of euros for the privilege of getting a non-search. This looks a brilliant move. Money for no service is great!!

So what is the business model of the EPO? Well, some say it is like a bridge. There is a lot of investment up front which leaves you with negative equity; however the expected tolls from people using the bridge (renewal fees for granted patents) pays for the cost in the long term.

Of course, to get to the long term you have to get past the short term and the medium term, but so far the EPO has not had to refinance or call on its sugar daddies (the Member States).

However, the EPO has another source of income. Using the bridge analogy, the capacity of the bridge is limited. It only allows about 60,000 travellers (patentees) across each year and yet about 150,000 turn up each year and pay for a ticket (with filing, search, examination and designation fees).

A very few are turned away (refused).

Very many simply give up and go away.

And many are happy to wait for a chance to cross, because although they want to get to the other side, they know that when they get there they will have to pay a lot in national trolls (sorry, tolls) at the other end. In recent years the national tolls have declined, but they can still be severe if you want to cover a lot of ground.

So the EPO has a brilliant third source of revenue - charging people to park while they are waiting to cross the bridge (renewal fees on pending applications).

The EPO income from internal renewal fees now exceeds that from renewal fees for granted patents by a substantial margin. Between 2002 and 2013: procedural fees income has increased by 45%; renewal fee income from granted patents has increased by 95%; and renewal fee income on pending applications has increased by 190%.

The unitary patent will complicate the economics of the model considerably. It appears that some are going by ferry (national route) rather than by bridge. We are in for interesting times.

Just to clarify that the fund we are talking about is NOT the EPO Pension Fund but the EPO Pension Reserve Fund.

Current (and future) EPO pensions are paid as running EPO expenses, the EPRF will need to be called on only if the EPO is unable to pay the pensions out of running expenses, and exists to protect the Contracting States against pension liabilites.

Much mischieve has been made and said over the years (generally by senior management in order to justfy reducing benefits for the majority of employees) by wrongly calling the EPRF the Pension Fund!

It should also be stressed that the EPO, unlike other public organisations, does have a Pension Reserve Fund which is meant to cover pensions in case the pension liabilities cannot be paid anymore from the cash income. The EU does not have such a fund, neither do most public services of the member states where pensions have to be paid from taxpayer's money.

And as for this idiotic question:"If we closed down the EPO today, who pays the pensions?", how about looking at the EPC some time ?

Article 37 - Budgetary fundingThe budget of the Organisation shall be financed: (a) by the Organisation's own resources; (b) by payments made by the Contracting States in respect of renewal fees for European patents levied in these States; (c) where necessary, by special financial contributions made by the Contracting States; (d) where appropriate, by the revenue provided for in Article 146;(e) where appropriate, and for tangible assets only, by third-party borrowings secured on land or buildings; (f) where appropriate, by third-party funding for specific projects.

http://www.epo.org/law-practice/legal-texts/html/epc/2013/e/ar37.html

Note: Article 146 relates to "Cover for expenditure for carrying out special tasks" in the context of Article 142 ("Unitary Patents").

Anon 19 Nov 12:03:00Actually, the Admin Council, years ago, decided that the Contracting States would not anymore be liable for any pension payments. Since then the EPO has made extra payments to the Reserve Fund. That fund is not used for current pension payments, hence isn't a pension fund per se but is a fall-back. Staff have also had to contribute more (originally there was an 8% cap but that has long since been overridden by the AC).

The real problem is that the EPO does not have a real governance. The Amministrative Council is responsible for checking how the president manages the office but unfortunately it fails to do so. There is no control on how the money is spent. For instance, a lot of money is spent for advertising (1.5 million/year for a program called ask Quest). The EPO is an organization which provides a service to the users of the system; it does not need marketing. The users are obviously paying for this. One day, somebody should also ask the president how much the event "inventor of the year" costs. If I am correct the EPO receives about 150.000 patent applications every year. Why should the 15 selected inventors be considered the best ones. And the big "show" costs a huge amount of money. What do the users say?

This user says the EPO should get on with its proper work. It does not exist to self-promote. However, the EPO is not alone. In the patent world we have the UK Patent Office attempting to re-invent itself to do things it should steer clear of. In other fields of life, probably most taxpayer funded organisations waste taxpayers money on self-promotion.

As regards pensions, for such an organization, they should not be funded by future generations of users or employees, or taxpayers. They should be funded based on returns from contributions made during employment, by employee/employer. This is how my pension works and I don't see how I would have a right to anything else.

It was mentioned that governments fund pensions differently, but, firstly, the EPO is not a country and has no substantive assets/oil/gas/citizens to back up such a system, and secondly, many countries are in a financial pickle due to their pension commitments.

"The real problem is that the EPO does not have a real governance. The Administrative Council is responsible for checking how the president manages the office but unfortunately it fails to do so."

Exactly.And those numpties even abolished their own independent Audit Committee in 2011 at the request of the President (who in his previous role as AC Chairman had personally signed the decision establishing it) !!!!!!!!http://techrights.org/2014/09/22/battistelli-audit-explained/http://techrights.org/2014/10/31/brimelow-and-battistelli/

You couldn't make this stuff up.

There is of course supposed to be another hierarchically superior layver of governance in the "conference of ministers" supposed to be convened at least once every five years under Article 4a of the revised EPC.

But that came into force in December 2007 and since then it seems to have been completely ignored ...

It has been rumoured that the members of the AC occasionally wake up when the lunch-bell sounds in the conference room of the main EPO building ...

The EPO President needs more than somebody to write his speeches. He also needs a real person to spell-check them.

Take a look at the job advert revealed by the Link offered by the Anonymous above. On the subject of "litarary" (sic) competence, the EPO tells us that only an expert knowledge of English will suffice. EPO, to save the laughter, if you are going to spell a word wrong, please let it not be "literary".

B latent cronyism puts him on a sticky wicketE ven some AC voices say that isn't cricketN ew rules and regs have left the staff stumpedO ur night watchmen removing people to be dumpedI f the umpires don't pull up their socksT his guy will continue to think outside the box

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